Global iron ore price forecast (April 2014)

Metal Expert Consulting continues to publish open quarterly reports to share its understanding of the iron ore market development in a medium- and long term and compare it with the consensus forecast of investment companies and analysts.

Global iron ore price started decreasing at the beginning of 2014 to reach $110/t (fines, CFR China) by the end of March. We believe the main reasons behind the decrease are the slowdown of pig iron and steel production in China as well as a huge oversupply of iron ore.

The decrease in steel consumption in China is related, among other factors, to the slowdown of GDP growth, tightening of credit policy and a drop of PMI. According to worldsteel.org and mysteel.net, in February China’s pig iron output fell by as much as 6 million t to 55 million t. Meanwhile, pig iron production is expected to keep decreasing in March as over first two months of the year pig iron output added by over 9 million t while steel production had stayed at relatively low levels since November-December 2013.

The iron ore prices are also depressed by growing stocks of Chinese consumers. In January, China’s iron ore imports increased by 13 million t to a record high of 87 million t. In February, imports dropped to 65 million t, which was still 12% higher than in February 2013. So, in January-March China’s iron ore stocks in ports grew from 84 million t to two-year high of 106 million t.

To prepare the consensus forecast, we have considered forecasts published in February-March. Earlier forecasts of investment companies have been disregarded because of a sharp drop of global iron ore prices.

Being positive that the downtrend will continue throughout this year offer, the majority of investment banks (Macquarie Bank, Credit Suisse, Morgan Stanley) offer the minimum forecasts (differing by 5-10%). Meanwhile, Deloitte Access Economics, Scotiabank, and Liberium Capital are most optimistic in their forecasts citing maximum price levels.

Note: To get the forecasts, all prices have been adjusted to a common benchmark – the CFR China price for Australian 62% Fe fines.

Comparison of actual iron ore prices in Q1 ($120/t) and Metal Expert Consulting’s forecast published at the end of 2013 ($131/t) shows that we have overestimated the possibility of basic scenario. At the same time, forecasts of investment companies are $5/t away from actual figures. Meanwhile, the consensus forecast published in our previous report was based solely on recent reports of investment banks.

The graph below shows the comparison of Metal Expert Consulting’s price forecast for Australian iron ore fines (62% Fe) in the Chinese market with the level of prices that investment and industry analysts expect adjusted to this basis.

Metal Expert Consulting’s quarterly forecast until 2015 is based on the Company’s internal methodologies with the use of non-linear dynamics methods. We believe that the most probable scenario of global iron ore market development will include trends observed in 2005-2006 or 2011-2012: following a relative stabilization in Q2, iron ore prices will decrease by $5/t by the end of the year. In January-March 2015, prices may drop to as low as $110/t to rise to $115-120/t afterwards.

For the first time in its history, Metal Expert Consulting’s forecast of global iron ore price development in 2014 is actually the same as the forecast of investment analysts (our forecast for Q2-Q4 2015 is more optimistic).

At the same time, our medium- and long-term iron ore price forecast isstill more optimistic than that of investment companies. We believe that a possible surplus of iron ore related to new capacities and the decrease in steel output (in China, first of all) will be somewhat balanced by the policy of suppliers.

According to our estimates, upon the decrease in iron ore quotes, “the Big Four” usually reduces investments into mining and restrain supply. Meanwhile, it is Vale, BHP Billiton, Rio Tinto and FMG who announce plans of iron ore capacity expansion for the next 5-10 years. So, these companies will be able to restrain the expected oversupply by suspending their expansion projects.

Unlike the majority of investment banks, we believe than the average annual price will not drop below $100/t in a long-term outlook despite the upcoming of new suppliers (with production costs below average), tightening of competition and decrease in major suppliers’ profitability. As of the beginning of 2014, costs of ore production and transportation to China and SE Asia, the biggest outlet, stand at $55-60/t for the most efficient of the existing suppliers (their profitability being about 120%), with the cost average for the market approaching $75/t CFR China (profitability is 65%). If iron ore production costs are assumed to go up 3-5% yearly in the next 10 years (inflation, growing labour, equipment, electricity and fuel costs, possibly toughening royalties and taxes on subsoil use, etc.), suppliers’ minimal costs will gain at least $20-25/t by the end of the period. As a result, the operating profit of 30% (equivalent to market average of about $55/t), which we consider minimal, can be earned provided iron ore is priced at $120/t, the level that Metal Expert Consulting forecasts.